James E. Towery is a past chair of the ABA Standing Committee on Client Protection and past president of the State Bar of California. He is a shareholder in the firm of Hoge, Fenton, Jones & Appel in San Jose, California.

If you apply to the state where you live for a vehicle registration, virtually every state will require that you show proof of financial responsibility, usually in the form of proof of insurance. Similarly, apply to your state for a contractor’s license, and again, you will be required to show proof of insurance. The reason for these requirements is simple and common sense: To obtain a state license, you must demonstrate that you have the ability to protect the public if anyone is injured by your negligence in your use of that license.

However, if you apply to your state for a license to practice law, you will have to pass a bar exam and demonstrate good moral character, but you will not be required to prove that you have malpractice insurance. And if you are negligent in using your license to practice law, and, as a result, one of your clients is injured, well, that’s the client’s tough luck.

This is one of the dirty little secrets of the legal profession: No state (except for Oregon, more on that later) requires that lawyers in private practice demonstrate proof of financial responsibility. One of the ironies of the situation is that many clients no doubt presume that all lawyers are required to carry malpractice insurance. Clients often discover the fallacy of that assumption for the first time when they attempt to sue their uninsured lawyers.

However, there has been an encouraging trend recently, led by state supreme courts rather than by bar associations. That trend is the adoption in several states of rules of professional conduct that require a lawyer who lacks professional liability insurance to disclose that fact to every client.

Although the organized bar has taken an ostrich-like approach to this issue, the problem of uninsured lawyers is a real one. Estimates vary, but most experts in legal malpractice insurance believe that one-third or more of American lawyers in private practice are uninsured. The question then becomes, is this a problem that needs to be addressed? Surprisingly, the response from the organized bar has largely been that the problem should be ignored.

The Oregon Model of Mandatory Insurance

Of all the jurisdictions, only Oregon has squarely addressed the issue. Since 1978, Oregon has had mandatory malpractice coverage for all lawyers in private practice, through the Oregon State Bar Professional Liability Fund. This fund affords minimal levels of $300,000 coverage per occurrence, at a current premium of slightly more than $2,000 per year. Oregon’s fund has worked well and protected clients ofall Oregon lawyers from the risk of un-insured losses.

However, there are sound reasons to question whether Oregon’s model would work well in other jurisdictions. The Oregon fund was established at a time when the insurance markets were far more favorable than they are today. Approximately 7,000 lawyers in private practice are covered by the Oregon fund. It is unlikely that this model would work as well in a state like California, which has more than 120,000 lawyers in private practice and a far greater diversity in types of practice and risk levels. The concern is that if proper insurance underwriting were used in a mandatory plan in a state like California, premium levels would be prohibitive for many lawyers, especially those in solo or small firms or those with limited incomes from their legal practice.

Mandatory Disclosure of Lack of Insurance

An alternative approach to the issue of uninsured lawyers is to require such lawyers to disclose to their clients their lack of insurance. California first adopted this approach in 1988 by including such a disclosure in written fee contracts, as required by California Business and Professions Code Sections 6147 (contingent fee contracts) and 6148 (hourly and other fee contracts). As originally enacted, the California statute required an affirmative disclosure by all attorneys as to whether they carried malpractice insurance. In the early 1990s this was amended to require a written disclosure only by those attorneys who lacked insurance. The California statute worked well, with a minimum of complaints from lawyers. However, that statutory requirement sunsetted at the end of 2000, and it has not yet been reenacted.

In 1999 the Supreme Courts of Alaska and South Dakota broke new ground in this area. Both courts adopted modifications of their Model Rules of Professional Conduct that mandated disclosure of the lack of malpractice insurance. In Alaska, for example, Model Rule 1.4 regarding communications was amended to require that a lawyer notify a client in writing if the lawyer had no insurance or insurance of less than $100,000 per claim or $300,000 annual aggregate, or if the lawyer’s insurance was terminated. The South Dakota rule amended Rule 1.4 to require a similar communication to clients as a component of a lawyer’s letterhead.

Anecdotally, it must be reported that, after the adoption of these rules in Alaska and South Dakota, the lawyers reacted in a predictable fashion. A significant number of lawyers who had previously been un-insured obtained malpractice insurance shortly before the effective date of the new rules. In other words, the new rules provided a positive incentive for uninsured lawyers to obtain insurance, so that they would not be required to make to clients the disclosure of lack of insurance.

In April 2001, Ohio joined this trend. The Supreme Court of Ohio voted (in a 5-2 decision) to amend the Code of Professional Responsibility to require lawyers who lack malpractice insurance to notify their clients of that fact using a standard form. The New Hampshire Supreme Court adopted a similar rule, which became effective on March 1, 2003, requiring disclosure to clients of lack of insurance. The Nebraska Supreme Court is also studying a proposed rule. In addition, the Virginia Bar has a rule requiring that lawyers report to the state bar whether they have malpractice insurance. In 2002 the Virginia Bar decided to put that information online to make it more accessible to the public. More than 25,000 hits were received on the bar’s website within the first week after that information was posted.

As a result of the movement of these various courts to require mandatory reporting, in 2000 the ABA Standing Committee on Client Protection decided to propose a similar amendment to the ABA Model Rules. The Standing Committee requested that the Commission on Evaluation of the Rules of Professional Conduct (Ethics 2000) include such a provision in the Ethics 2000’s general overhaul of the ABA Model Rules, but Ethics 2000 declined the invitation. After encountering some opposition from other ABA entities and a general lack of support, the Standing Committee on Client Protection elected not to forward any such proposal to the ABA House of Delegates.

Objections to Mandatory Reporting

As the debate on this issue of mandatory reporting has spread during the past several years, opponents have voiced a variety of objections to the concept. Some objections are philosophical, others are technical in nature.

One of the most frequent objections is to question the need for such a rule. Where is the evidence that uninsured lawyers are currently harming clients? Where is the evidence of malpractice judgments that are uncollectible owing to lack of insurance?

It is a fair criticism that no study exists providing data on these points. The entity within the ABA that most logically could conduct such a study, the Standing Committee on Lawyers’ Professional Liability, has never conducted one.

However, a study is hardly necessary to demonstrate that client harm results from uninsured lawyers. Without question, lawyers who lack insurance commit malpractice, just as do those with insurance. And no one can seriously question that claims against uninsured lawyers are often abandoned, precisely because there is no available insurance. If you doubt this, simply ask any lawyer in your community who handles plaintiff’s legal malpractice claims about the subject. Such a lawyer will tell you that in evaluating whether to file such a claim, a threshold issue is whether the lawyer is insured. If the claim is modest (i.e., with potential damages of $100,000 or less), many plaintiff’s malpractice lawyers will elect not to file suit; the risk that any judgment will prove to be uncollectible, in light of how difficult these claims are in other respects, simply makes such claims not worth pursuing. It is difficult to count claims never pursued owing to lack of insurance.

Another objection to mandatory reporting is the suggestion that client security funds already address the issue. That is simply not the case. Client security funds have a more limited purpose: to reimburse clients when lawyers steal money. The rules of client security funds do not permit reimbursement for simple acts of negligence by a lawyer. Malpractice claims are the only manner by which a client can seek redress for simple acts of negligence.

One technical objection is that mandatory disclosures don’t include the nuances of the adequacy of the legal malpracticecarrier or the issue of when a diminishing limits policy (where liability coverage diminishes as expenses of defense are incurred) causes coverage to fall below a certain level. It is true that such nuances are not covered by many of the mandatory disclosure rules. Certainly such factors should be considered in drafting disclosure rules. However, these are not compelling arguments for failing to address the problem at all. An imperfect solution to the problem of uninsured lawyers is better for the public than no solution at all.

Conclusion

Law school professors commonly offer the warning, “Allow me to frame the question, and I will dictate the answer.” In the debate over mandatory reporting rules for uninsured lawyers, much depends on how the question is framed.

Supporters of mandatory disclosure frame the question as follows: When a client hires a lawyer, is the lawyer’s lack of insurance a material fact that the client is entitled to know? It is difficult to fashion a persuasive argument that clients are not entitled to that information. Lawyers operate under a state license and have a monopoly on practicing law. With that monopoly go certain obligations. Full disclosure to clients of material information regarding their representation is certainly one of those obligations. And if you don’t believe that most clients would consider information about lack of insurance to be material, I suggest you put that question to a cross-section of your own clients. You may be surprised by the response.

Con

By Edward C. Mendrzycki

Edward C. Mendrzycki chairs the ABA Standing Committee on Lawyers’ Professional Liability. Formerly a litigation partner at Simpson, Thacher & Bartlett in New York, Mendrzycki is currently of counsel to the firm. He wishes to acknowledge Glenn Fischer, Assistant Staff Counsel to the Committee, for his assistance in preparing this article. Mandatory disclosure rules address a problem they cannot really solve. Should a lawyer’s failure to disclose his or her insured status violate the canons of professional ethics? While several states have answered “yes” to this question, others are actively debating it. In this writer’s view, an ethical rule requiring lawyers to disclose whether they have malpractice insurance may sound like a good idea on its face, but, realistically, it provides no actual protection mechanism for clients, while engaging a disciplinary response to a challenge that does not truly involve legal ethics.

But let us first approach the issue with some frankness; having malpractice insurance is almost always better than not having it. Even if you do not need it, it certainly cannot hurt you. We learn early in our careers that we are expected to supply “both a belt and suspenders” to our clients when practicing our craft. Of all professionals, lawyers are probably the most aware that there are no guarantees in life and that things can and do go wrong. In fact, our clients often seek our services specifically to help prevent the things that can and do go wrong, or to help deal with the consequences when a lack of foresight leads to a hard lesson learned by hindsight. Many times we advise our clients to obtain insurance to cover their automobiles, their businesses, their homes, and their lives. Should lawyers not follow their own advice?

The answer is, of course, they should. But “should” is not the equivalent of an ethical “shall.” And that is the real question at hand, whether our code of ethics should require lawyers to have insurance or to inform their clients when they do not. That is the question that requires a negative answer.

Before explaining that answer and the reasons behind it, it is important to have a basic understanding about the nature of lawyers’ professional liability (LPL) insurance. LPL insurance is not the same as many other types of insurance lawyers recommend their clients buy to protect their homes, cars, and other interests. At the outset, then, a client’s understanding of what it means when a lawyer “has insurance” is very likely to be inaccurate. In point of fact, many practicing lawyers do not fully understand the nature and scope of their professional liability coverage.

LPL policies are “claims-made” policies, meaning that coverage is triggered only if a claim is actually made during a particular policy period (typically one year). This sounds simple enough, but consider that claims are rarely made in the same year that a negligent act occurred. Because of the nature of the work many lawyers perform (real estate, probate and estate planning, and protracted litigation, to name a few) errors may not be discovered until many years after they occurred.

Therefore, if a lawyer has insurance on the day he or she commits an error, it does not necessarily mean that same coverage (or any coverage) will be in effect when a claim is made years later. If the original LPL insurance policy was not renewed, it does not matter that the lawyer was insured at the time the error was made. In addition, even if a lawyer purchased a new or different policy from the one in force at the time of the error, coverage will be excluded unless the replacement coverage specifically covers “prior acts,” or errors that occurred before the inception of the new policy. To make matters even more complicated, coverage can also depend upon the interplay of a number of other factors, such as the size of the deductible (it is not uncommon for some policies to have minimum deductibles of $5,000), the number and nature of prior claims (LPL policies are subject to limits of liability), the size of claims, and the type of malfeasance alleged (intentional acts are generally not covered).

Because the existence of a policy today may have no real impact on events surrounding coverage for a claim that is made sometime in the future, disclosure of that insurance policy to a potential or existing client may not amount to much useful knowledge. It may even be harmful. Giving the public the impression that they are almost unquestionably protected by insurance, when they may not be, is likely to cast the profession in a bad light. In the eyes of many, lawyers already have a reputation for “working the system” to avoid responsibility for their clients’ actions as well as their own. Why contribute to this perception, especially when one of the purposes behind a mandatory disclosure rule is to instill greater confidence in the legal profession?

But besides being potentially misleading, there is an even more fundamental problem with a mandatory disclosure rule. It invokes the disciplinary system to solve a problem that is neither moral nor ethical in nature. Ethics rules, in general, exist both as a set of practice guidelines and as an enforcement mechanism to protect clients from potential abuse by lawyers. But can LPL insurance coverage really stop the types of abuses the ethical rules are meant to prevent? LPL insurance typically will not cover the most flagrantly blameworthy types of conduct lawyers are capable of—intentional acts of misconduct or behavior that, in the legal field, would typically support a disciplinary charge (such as lying to or stealing from clients). On the contrary, LPL insurance, by and large, only covers lawyers for their acts of negligence, but negligence generally has little to do with an attorney’s moral character and conduct, and it is these that disciplinary rules are intended to monitor.

The truth is that neither the purchase of insurance nor the failure to purchase insurance implicates the ethical tenets described in the Model Rules. Buying insurance is unquestionably a “best practice” in most situations, but a best practice that is aspirational and does not necessarily involve an ethical underpinning. Quite simply, there is no tenable link between insured status and conduct requiring discipline. Although purchasing insurance may be a sound business practice, it does not implicate the traditional notions of morally “right” and “wrong” behavior that the disciplinary rules were designed to address. There is no empirical evidence or objective data to show that a lawyer who has insurance is more likely to act ethically than a lawyer who has no insurance.

And this is an important point when it comes to those lawyers who choose not to carry insurance or who choose to be self-insured. A mandatory disclosure rule is a distinct disadvantage to those lawyers whose practices function on a fixed or very limited budget, or on a part-time or limited-scope-representation basis. These lawyers may choose to be uninsured because they choose their cases and clients specifically to avoid risk. Many of these lawyers offer services to particularly underserved segments of society because they can do so inexpensively without sacrificing quality. If these lawyers are now forced to purchase expensive insurance policies in order to remain competitive (or in the market at all), it could potentially drive them out of their established practice area or the legal field altogether. This is because of a fear that the potential client will draw some negative inference about their abilities to deliver quality representation based upon their uninsured status. In effect, the lack of insurance becomes a stigma (manufactured by the profession) that has almost no bearing on a lawyer’s ability to effectively serve a particular client.

We should not lose sight of the fact that professional liability insurance is generally purchased to protect the covered lawyer. And, although insurance may provide an injured client with a source of compensation in the event that a lawyer commits malpractice, there is no objectively verifiable data indicating that malpractice claims are significantly more prevalent among uninsured attorneys than among insured attorneys. There is hardly a strong enough impetus to warrant invoking the disciplinary system as an enforcement mechanism; it is not as if the profession is facing a widespread epidemic of malpractice. Even if it were, having insurance will not eliminate the source of either substantive or administrative errors. Only education, conscientious risk management, and loss-prevention techniques will accomplish that.

There is no empirical evidence showing that simply stating that a lawyer is uninsured offers any useful information to a client who is making a decision whether to hire counsel. In fact, it may be of no use at all, unless the lawyer launches into a lengthy explanation of the type described above about the nature of LPL coverage. There are many other “material” facts that are probably more important in determining whether a client hires a particular lawyer, such as a lawyer’s past disciplinary history, how much experience a lawyer has in a particular area of law, and the generally high investment of money and time that litigation requires. No one proposes making these disclosures mandatory, although they are likely to have a significant impact on the overall outcome of the representation.

Educating the public to inquire intelligently about the significance of LPL insurance is likely the better approach. We accept the principle of caveat emptor in all manner of other business transactions, and hiring a lawyer should be no different. Merely stating on one’s letterhead, or in one’s retention agreement, that the firm does not carry liability insurance is not a productive dialogue. And if clients do not know or care to inquire about insurance, how can we be assured that they will truly grasp the import of the mandatory disclosure required by the rules?

Overall, a mandatory disclosure rule would fail to address the problem it tries to solve. And, at the same time, it would confound the very purpose it is meant to serve. To many of our clients, the law is complex and nebulous, and there is no need to further complicate the attorney-client relationship or negatively affect the perception of the profession.